Jzanzig_Acc 512 - Chapter 12

8/3/2019 Jzanzig_Acc 512 - Chapter 12

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Chapter 12

Decentralization and Performance

Evaluation


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Presentation OutlineI. The Concept of Decentralization

II. Types of Responsibility CentersIII. Evaluating Investment Centers with

Return on Investment (ROI)

IV. The Balanced Scorecard

V. Transfer Prices


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I. The Concept of DecentralizationA. Decentralization Defined

B. Advantages/Disadvantages ofDecentralization

C. Two Reasons for Evaluating Subunit

Performance

D. Responsibility Accounting


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A. Decentralization Defined

Firms that grant substantial decision making

authority to the managers of subunits arereferred to as decentralized organizations.

Most firms are neither totally centralized

nor totally decentralized.


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B. Advantages/Disadvantages of

DecentralizationAdvantages

Better information,leading to superior

decisions.

Faster response tochanging circumstances.

Increased motivation of

managers Excellent training for

future top levelexecutives.

Disadvantages

Costly duplication of

activities. Lack of goal congruence.


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C. Two Reasons for Evaluating

Subunit Performance

Identification of successful areas of

operation and areas in need of

improvement.

Influence over the behavior of managers.

Note that it is quite possible to have a good

manager and a bad subunit.


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D. Responsibility Accounting Managers should only be

held responsible for costsand revenues that they

control.

In a decentralizedorganization, costs and

revenues are traced to theorganizational level where

they can be controlled.

(See Illustration 12-3 on p.421)


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II. Types of Responsibility

Centers

A. Cost Centers

B. Profit Centers

C. Investment Centers


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A. Cost Centers

A cost center is a subunit thathas responsibility forcontrolling costs but not for

generating revenues.

Most service departments

(i.e., maintenance, computer)are classified as cost centers.

Production departments maybe cost centers when they

simply provide components

for another department. Cost centers are often

controlled by comparingactual with budgeted or

standard costs.


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B. Profit Centers

A profit center is a subunit

that has responsibility of

generating revenue and

controlling costs.

Profit center evaluation

techniques include:

Comparison of current year

income with a target or budget.

Relative performance evaluationcompares the center with other

similar profit centers.


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C. Investment Centers

An investment center is a

subunit that is responsible for

generating revenue,

controlling costs, and

investing in assets. An investment center is

charged with earning income

consistent with the amount of

assets invested in the segment.

Most divisions of a company

can be treated as either profit

centers or investment centers.


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III. Evaluating Investment

Centers with Return onInvestment (ROI)

A. The Components of ROI

B. Measuring ROI Income and InvestedCapital

C. Problems with Using ROID. Residual Income (RI) as an Alternative to

ROI


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A. The Components of ROI

ROI has a distinct advantage over income as a measure ofperformance since it considers both income (the

numerator) and investment (the denominator).

ROI =

Income

Invested capital

ROI = IncomeSales

x SalesInvested capital

ProfitMargin Investment Turnover

The breakdown of the formula shows that managers can increase

return by more profit and/or generating more sales for each

investment dollar.


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B. Measuring ROI Income and

Invested CapitalROI Income

Investment center income

will be measured using netoperating profit after taxes

(NOPAT).

NOPAT should exclude

nonoperating items such as

interest expense and

nonoperating gains and

losses, net of the tax effect.

ROI Invested Capital

Invested capital is measuredas total assets less

noninterest bearing currentliabilities.

Noninterest bearing currentliabilities are deducted from

total assets because they area free source of funds andreduce the cost of theinvestment in assets.

See Illustration 12-4 on page 426


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C. Problems with Using ROI

Investment in assets is typically measured using historicalcost. ROI becomes larger as assets become depreciated.

This may result in managers taking unnecessary delays in

updating equipment.

Managers may turn down projects with positive net presentvalues, simply because accepting the project results in a

reduced ROI. In other words, projects may be turned down

if they provide a return above the cost of capital but below

the current ROI.


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D. Residual Income (RI) as an

Alternative to ROIResidual Income = NOPAT Required Profit

= NOPAT Cost of Capital x Investment

= NOPAT Cost of Capital x (Total Assets

Noninterest Bearing Current Liabilities)

Residual Income (RI) overcomes the underinvestment problem of

ROI since any investment earning more than the cost of capital will

increase residual income.


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IV. The Balanced Scorecard

A. The Balanced Scorecard Approach

B. The Balanced Scorecard Dimensions

C. How Balance is Achieved


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A. The Balance Scorecard

Approach A problem with just

assessing performance with

financial measures is that

such measures are

backward looking.

The balanced scorecard

approach also focuses on

what managers arecurrently doing to create

future shareholder value.


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B. The Balanced Scorecard Dimensions

Financial PerspectiveIs company achieving

financial goals?

Financial PerspectiveIs company achieving

financial goals?

Internal Process

Is company improving

critical internal processes?

Internal Process


critical internal processes?

Customer Perspective

Is company meeting

customer expectations?

Customer Perspective

Is company meeting

customer expectations?

Learning and Growth


its ability to innovate?

Learning and Growth


its ability to innovate?

Strategy


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C. How Balance is AchievedPerformance is assessed across a balanced set of

dimensions (see Illustration 12-10 on p. 437).

Quantitative measures (e.g., number of defects)are balanced with qualitative measures (e.g., rate

of customer satisfaction).

There is a balance ofbackward-lookingand

forward-lookingmeasures.


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V. Transfer Prices

A. Transfer Price Defined

B. Market Prices as the Maximum

C. Variable Cost as the Minimum ExcessCapacity Exists

D. Variable Cost Plus Lost Contribution

Margin on Outside Sales as the Minimum

Excess Capacity Does Not Exist

E. Transfer Pricing and Income Taxes in an

International Context


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A. Transfer Price Defined

The price that is used to

value internal transfersof goods and services

within the same

company is known as

the transfer price.


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B. Market Prices as the

MaximumThe transfer price should

not exceed what the

acquiring division wouldhave to pay for a similar

good and given set of

conditions on the outside

market. If the outsidemarket is cheaper, the

good should be acquired

outside the organization.


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C. Variable Cost as the Minimum

Excess Capacity ExistsThe supplying divisionshould not set a transfer

price that is lower thanthe variable cost ofsupplying the goodand/or service to the

requesting division. This

may be less than thevariable cost of serving

an outside customer.


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D. Variable Cost Plus Lost

Contribution Margin on OutsideSales as the Minimum Excess

Capacity Does Not Exist

The minimum transfer pricewill add a lost

contribution margin onoutside sales if the

supplying division mustturn away outside

customers to provide thegood and/or service to

the requesting division.


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E. Transfer Pricing and Income Taxes

in an International Context

When income tax ratesbetween countries differ

significantly, a supplier ina lower rate country willwant to charge the

purchasing division ahigher transfer price to

lower taxable income forthe purchaser in the

higher rate nation, andvice versa.


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SummaryDecentralization and Responsibility

Accounting

Cost, Profit, and Investment Centers

ROI

Residual Income

Balanced Scorecard

Transfer Pricing

Documents

Jzanzig_Acc 512 - Chapter 12